Income Inequality, The Major Problem of Our Time?

There has been a strange conflux of articles this week hovering vaguely around the topic of income inequality:  Krugman’s post on Larry Summer’s Secular Stagnation Hypothesis, Wonkblog on the failure of 401ks for all but the affluent, the unfortunate food drive at Walmart for its own employees, a call for higher minimum wage, more Social Security and probably some I am missing.  Oh and Paul Ryan trying to cure poverty by cutting welfare and rich people’s taxes.  The point is that it is getting coverage and I am seeing a lot of comments that seem completely wrong from an economics perspective.  I say that as someone whose discipline is not economics, but as an avid student nonetheless.

Lets start by tackling the minimum wage and Walmart’s pay.  I thought it was fairly common wisdom (whether true or  false) that Henry Ford paid his workers enough to buy his cars as a good business decision not out of generosity.  Corporations in America seem to have forgotten this lesson in their battle to depress the wages of their workers.  Walmart is simultaneously complaining that their sales have slowed because of the recession and yet not paying their workers enough to shop at Walmart.  Which raises the question of where people are shopping if they can’t afford Walmart?  Apparently, dollar stores are growing like crazy.  A very sad commentary on how we have squeezed the poor.

So a natural reaction is to call for raising the minimum wage to a living wage.  People argue that then everything would become more expensive, but things are not so simple.  Such people are engaging in a variant of the Lump of Labor Fallacy where they think the economy is zero-sum so if we give low wage workers more it must come from somebody else’s piece.  Even if that were true corporate profits are at an all-time high and so there is plenty of give there if we want to raise the minimum wage.  However, that is not how the economy works.  There are feedback cycles, especially in a depressed economy, that may cause an increase in the minimum wage to expand the economy (see paradox of toil, paradox of flexibility) and thereby increase everyone’s slice of the pie.  It’s paradoxical, but as Krugman often writes, that’s what you get in a liquidity trap.  It’s also similar to how, contrary to popular belief, immigrants are usually good for the economy.

Now all of this ties into the Secular Stagnation Hypothesis which you should read about elsewhere, but is essentially a theory that the modern economy requires bubbles in order to reach full employment and/or negative interest rates. The usual prescription is then to increase inflation so as to produce lower interest rates.

What are the causes of such an anemic economy?  Well there are theories that we are just so productive that we don’t need everyone to produce all the things we need.  Or maybe the pace of innovation has slowed.  I think both fall into a lumping fallacy.  Unless all consumption needs are met for everyone you can always find something to sell that someone wants to buy and you would need someone to make it.  It’s why we never ascended (or descended) into the leisure paradise that Keynes predicted.  You can never overestimate the human capacity to consume more stuff.

I think both of the above reasons are actually symptoms of an underlying structural problem, namely, the vast income inequality in America today.  If people are too poor to consume then there is no reason to hire people to produce more stuff.  So in a sense we are “too” productive, but it’s not because of a lack of desire to consume more, but one of an inability to consume more.  Walmart is doing disappointing sales, but luxury retailers are doing a booming business.  The problem is that a rich person can only own so many ugly Louis Vuitton bags.  So if our economy is slowly directed toward producing stuff for rich people, of course we are going to run into a situation where we don’t need everyone employed.

Similarly, as we hollow out the middle class we change where innovation is directed.  I saw an article where Proctor and Gamble says they have basically stopped catering to the middle class niche of products, either going bargain quality or high end.  What is the point of coming out with some great new product if the rich can only buy a handful and everyone else is too poor to afford it?  What you really want is something like the 90s when PCs became affordable for the average person and it supercharged the economy.  However, as the gulf between the haves and the have-nots increases the chance of such an event becomes much less probable.

As a a kind of microcosm look at all the buzz around various free social media sites that can’t seem to make any money.  That’s because they have a bunch of poor people as users that would probably flee at the first sign of a fee.  Or look at free-to-play games where all the money is made from rich whales and the vast majority of players never pay a dime.  It works a lot like that Paid Friends article recently on the NYT.  The free players are supported by the rich players who in turn get a bunch of people they can interact with in the game.  This is the future of our economy if we don’t change things, an economy centered around servicing the needs of rich people.  It’s already happening with, once again, the abysmal NYT Sunday Style section containing an article about a service to give the nannies of rich people a proper culinary education.

My attempt at a solution is pretty simple.  Rather than increasing Social Security (why are we only OK with old people welfare?) or the minimum wage we just provide a guaranteed basic income (GBI) and universal healthcare.  We are a rich country that could afford this for our citizens.  I would then abolish almost all other forms of welfare.  This significantly reduces the complexity of our welfare system since we at worst are just mailing out checks to people.  No more donut holes in benefits or high effective marginal tax rates on the poor or onerous means-testing.  You get a deposit in your government bank account every month (did you know that most poor people don’t have bank accounts and have to pay for check cashing services?) and off you go to spend the money on whatever you think you need.  Conservatives should get behind the freedom-enhancing effects of GBI over other forms of welfare, but of course they wont.

A GBI has a number of benefits.  You get a macroeconomic stabilizer as there is a floor of demand set by the GBI.  Furthermore you drastically increase job quality as now the choice is between working for a bit more consumption compared to before when it was working because you don’t want to die.  Lets see how corporations like it when labor actually has options.  I suspect they wont be able to squeeze them quite as hard as they have the last few decades.

Of course, this amounts to a massive redistribution of income, but that is I think our best tool for combating income inequality.  The cause of income inequality are many and hard to pin down.  I could name a few culprits that could probably be mitigated by good legislation, but I suspect it is mostly a consequence of an increasingly globalized economy.  So we just have to treat the symptoms and the GBI is the way to do it.

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